FOMC Statement & Potential Impact on Fixed Income

Posted on March 22, 2018

Following the Fed’s announcement, please see below for market views from the Global Fixed Income, Currency & Commodities Team (GFICC):

Consistent with our and the market’s expectations, the Federal Open Market Committee (FOMC) increased the Fed Funds rate to a range of 1.50% – 1.75%. At this meeting, Fed members also updated their Summary of Economic Projections and Chairman Powell hosted his first quarterly press conference.

The March statement served as a mark-to-market of current conditions and an optimistic tone toward the medium term outlook. The Committee continues to acknowledge that its preferred measure of inflation is running below its target, but acknowledged supportive base effects going forward. The FOMC continues to characterize the path of future rate hikes as gradual. The Fed statement did not reference the balance sheet but the process will continue in the background. In April, the maximum run-off per month will rise from $20bln to $30bln ($18bln Treasury/$12bln MBS).

Committee Statement

We can break the statement into three parts:

Economic Assessment – the Committee upgraded its positive assessment of the labor market (after a three month average of 242,000 new jobs added), but did acknowledge the recent moderation in growth data in Q1 2018. Once again, they acknowledged that inflation remains below target.

Outlook – the Committee expects further growth and strengthening of labor market conditions to continue longer than previously expected, the result of the recent fiscal initiatives. Additionally, they expect inflation to return to the 2% YoY objective and have acknowledged this could happen earlier than expected due to base effects. Nevertheless, they continue to monitor inflation developments closely.

Forward Guidance – the Committee continued to describe future actions as gradual and stressed that its current policy stance was still accommodative.

There were no dissenters.

Summary of Economic Projections

Investors had priced in nearly 100% probability of a rate hike at this meeting, so the SEPs and the “Dot Plot” took on greater importance. Within the projections, the growth forecasts were upgraded for 2018 and 2019. The Chair mentioned the upgrade to growth reflected changes to fiscal policy (as longer run growth expectations remained unchanged). The inflation forecasts were unchanged in 2018 but increased to above the Fed’s target in 2019 and 2020, suggesting the FOMC members were comfortable with a small overshoot. The unemployment rate estimates were cut rather dramatically for the next few years while the long-run unemployment rate was also shifted downward, signaling that further declines in the unemployment rate may lead to less wage growth than otherwise expected.

The median dots were unchanged in 2018 reflecting two more rate hikes this year, but did shift upward in 2019 and 2020 by one hike and 1.5 hikes, respectively. The Committee also shifted the long-run dot upward by half a hike, reflecting fewer headwinds to the supply side of the economy.

Chair’s Press Conference

At Chairman Powell’s first press conference, he sounded optimistic in light of recent labor market and growth developments with an open mind toward the long-run impact of fiscal policies on US capacity. The Chair communicated his belief that inflation and wage growth are only moving up slowly (flat Phillips curve). He communicated that the Fed’s existing framework of gradual rate hikes still remained appropriate.

Our View:

The FOMC statement was reflective of moderately strong data in Q1 2018 and reflected continuity of views between former Chair Yellen and current Chair Powell. Positive developments in growth and inflation have allowed them to feel comfortable continuing to communicate a gradual path for moderate rate increases and a slow balance sheet run-off.

The Committee continues to view future rate hikes as warranted. Fiscal initiatives have translated into higher growth expectations. If fiscal policy stimulus does indeed result in higher growth rates and faster inflation, the Committee median will shift to a total of four rate hikes in 2018 as soon as the June FOMC meeting.

Four open spots remain on the Board of Governors, including the Vice Chair of the Board which is expected to be announced shortly. Marvin Goodfriend has been nominated for one of the remaining four positions but his nomination is still hung up in the approval process.

Improving global growth will create an environment that is supportive of risk assets at the expense of Treasury yields, despite the coming contraction in global central bank liquidity. The change in the FOMC’s balance sheet has been widely publicized and well telegraphed and the knock-on impact to markets so far has been muted as the run-off remains minimal. We anticipate the size of the run-off in 2018 will be between $300 – $400 billion, dependent on MBS pre-payments.

We expect that the reduction in global central bank liquidity in 2018 will move more into the market’s purview as the year progresses and could cause an increase in volatility.

After remaining stubbornly weak, we see signs that inflation is rising to a pace closer to the Fed’s longer-run target, albeit at a gradual pace. This will allow 10-year yields to continue to move higher in 2018.

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